The Economics of Dependency

How Countries Hit the Demographic Sweet Spot

By Sami J. Karam

Demographics are among the most important influences on a country’s overall economic performance, but compared with other contributors, such as the quality of governance or institutions, their impact is underappreciated. Demographic factors, such as the age structure of a population, can determine whether a given economy will grow or stagnate to an even greater extent than can more obvious causes such as government policy. One of the most consequential aspects of demographics as they relate to the economy is a phenomenon known as the “demographic dividend,” which refers to the boost to economic growth that occurs when a decline in total fertility, and subsequent entry of women into the work force, increases the number of workers (and thus decreases the number of dependents) relative to the total population. The demographic dividend has contributed to some of the greatest success stories of the twentieth century, and countries’ ability to understand and capture this dividend will continue to shape their economic prospects well into the future.

Demographics powerfully shape a country’s performance, but their role is often under appreciated

BABY BOOMS

Prior to the twentieth century, the age structure of most populations could be visualized as a pyramid. High fertility and mortality rates meant that the very young, who formed the wide base of the pyramid, were always the most populous group in a society, with a shrinking number of people in each successive age range forming the narrowing sides of the pyramid, culminating in the top, which contained a small number of the very elderly. In such societies, the “dependency ratio,” or the ratio of dependents to workers—defined by the UN as the number of people under 15 and over 64 years old divided by the number of those between 15 and 64—was more or less stable, meaning that there were at most times a steady and sufficient number of workers to take care of dependents, made up of children and the elderly. Only large wars, pandemics, or deep economic crises disrupted the shape of the pyramid.

In the twentieth century, however, demographics in the industrialized nations became more volatile as a result of crises such as the two world wars and the Great Depression. In the United States, for instance, the total fertility rate, which measures the average number of children per woman, fell from 3.0 in the mid-1920s to 2.2 in the mid-1930s. Then, during the postwar baby boom, total fertility shot up to 3.7 in the late 1950s before dropping to 1.8 in the late 1970s. Since the early 1980s, U.S. fertility has fluctuated within the range of 1.8 to 2.1.

The United States and China are two very different examples of how an economy can reap the demographic dividend

It was this volatility that allowed the United States, like industrialized countries elsewhere, to benefit from the demographic dividend. In essence, the demographic dividend is what happens when growth in a country’s working-age population coincides with a declining dependency ratio. This is usually the result of two related developments: first, declining fertility, which decreases the number of dependent children relative to adults; and second, increasing female labor force participation, which is enabled by declining fertility as well as by broader social trends such as female literacy and changing cultural norms around women and work. The combination of the two means that there is more income per capita, freeing up money for discretionary spending on income and investment.

Consider the case of the United States from the mid-1970s onward. Between 1975 and 2015, the size of the U.S. working-age population grew from 141 million to 213 million. At the same time, modern social norms and new technologies, such as the birth control pill and the washing machine, freed more women than ever before from the constraints of homemaking and child rearing. According to the U.S. Department of Labor, in 1940 only 20 percent of American women were in the work force, and in 1966 that number was still only 40 percent. But by 1998, 60 percent of women were working, accounting for over 45 percent of the U.S. work force. Throughout this period, fewer births and more workers combined to lower the dependency ratio. These trends were a major driver of the long economic boom that started in 1983 and ended with the financial crash in 2007–08. During the boom, U.S. real GDP growth averaged 3.4 percent annually.

Indeed, similarly positive demographic trends were evident throughout the developed world—in Europe, the United States, Japan—during the second half of the twentieth century, leading to a massive increase in wealth and well-being across the globe. But this was true not only of the rich world—one of the largest development success stories of recent decades, China, also benefited from the demographic dividend. After the end of its civil war in 1949, China’s population exploded as death rates declined even as fertility remained high—total fertility, according to the UN Population Division, averaged 6.0 in the 1950s and 1960s, a level matched today only by a few African countries. But in the early 1970s Chinese fertility began to fall, reaching 2.9 in 1979 just before the introduction of the one-child policy, after which it reached a low of 1.5 in the year 2000. At the same time, China had carried out extensive literacy campaigns for several decades. By 1990, Chinese youth female literacy had reached 91 percent, the world average at the time for upper-middle-income countries, despite China having a per capita GDP of $987, lower than Sudan or Yemen. Dependency ratios fell rapidly, from 80.7 dependents per 100 workers in 1965 to 34.5 in 2010. Combined with rapid development on other measures—electricity consumption was rising, as was international trade—this demographic profile proved a boon to Chinese growth.

GROWING UP

The United States and China therefore show two very different examples of how an economy can capitalize on the demographic dividend. In the United States, western Europe, Canada, Australia, and other rich countries, the economic benefits tied to high levels of literacy and economic development were already present when their dependency ratio began to decline; in China, both the social indicators and the trends in fertility were the product of top-down, coercive state action. All, however, benefited from demographics in the quarter century from 1983 to 2007.

Yet today these favorable demographic trends are reversing themselves. As the chart below shows, in the advanced economies, the dependency ratio bottomed out, first in Japan in the early 1990s and later in Europe and the United States between 2005 and 2010, after which it began to rise.

In each instance, the shift in the direction of the dependency ratio coincided with falling stock markets and the onset of a recession or economic stagnation. Dependency ratios, in fact, are rising in most of the world’s major economies and will continue to do so for many decades, which could be a major drag on economic growth. In the United States, for instance, the retirement of the large baby boom generation will lead to a bulge in the number of dependents even as population growth stagnates outside of new immigration. And in China, the positive effects of declining child dependency having been exhausted, the negative effects of the rising old-age dependency ratio will limit growth well into the twenty-first century.

Although the Chinese government has set GDP growth targets this year to a relatively low 6.5 percent, the experience of Europe, Japan, and the United States suggests that the country’s economy will need other drivers to mitigate the impact of deteriorating demographics.

SPREADING THE WEALTH

But if aging populations in the more developed countries herald an end of their demographic dividends, global demographics are not uniformly stagnant. Many parts of the world, including India, parts of Southeast Asia, and sub-Saharan Africa, still have high fertility rates and high population growth. All have fertility rates on a downward trajectory, giving them—in theory—an opportunity for a demographic dividend a decade or two from now, provided they can get other prerequisites for growth, such as literacy, infrastructure, and governance, in order.

Among the BRIC countries, Brazil, Russia, and China will be facing similar demographic headwinds as the United States and Europe. Yet India stands out for its rising population and falling dependency ratio. The country’s fertility rate now stands at 2.34 and is expected to decline to 1.89 by 2050, and between 2015 and 2040 its dependency ratio will fall from 52.4 to 47.1. If Indian Prime Minister Narendra Modi’s attempts to modernize the economy prove successful, India could see impressive growth in the medium- to long-term future.

The number of working-age Africans is expected to grow by 800 million over the next 35 years.

In sub-Saharan Africa, meanwhile, the population is still booming. In the next 35 years, the number of working-age Africans is expected to grow by 800 million, from 518 million people in 2015 to 1.31 billion in 2050—an explosion that carries with it the potential for either a sustained boom or a grinding disaster. In theory, sub-Saharan Africa is in the same demographic sweet spot as India, with a rising population and declining dependency ratio. Fertility rates are falling across the board, albeit from exceedingly high levels. The total fertility rate for the region is now at 4.75 children per woman and expected to fall to 3.15 by 2050, during which time the dependency ratio is predicted to decline from 85.6 to 62.4. These are still very high figures for 2050, but China’s fertility fell rapidly from the 1960s to the 1970s, even before the introduction of the one-child policy, so an even quicker fall in African fertility is a possibility as long as some of the largest states, such as Nigeria and Ethiopia, are able to develop stronger state capacity.

Indeed, there are many reasons to be optimistic about Africa. Although the road ahead is still long, there has been considerable progress toward the Millenium Development Goals set in 2000, especially in the areas of education, gender equality, and health care. And although Africa’s demographics at present are a burden, they could prove beneficial in the near future. There is a clear correlation between GDP per capita and youth of the population, with younger countries tending to be poor and older countries tending to be rich. In western Europe and North America, for example, less than 40 percent of the population is under 30 years old, and in Japan it is less than 30 percent, but in almost every state in sub-Saharan Africa over 60 percent of the population is younger than 30, and GDP per capita is correspondingly low. Many of these countries are laboring under the additional burdens of poor governance and rampant corruption. But if paired with improvements in literacy, infrastructure, and governance, the projected decline in fertility and dependency ratios over the coming decades could start a virtuous cycle that would significantly boost today’s poorest economies.

Sub-Saharan Africa’s population explosion carries with it the potential for either a boom or a disaster

WHAT NOW?

Demographics played a leading role in economic development in the twentieth century and will continue to do so in the future. If the world saw unparalleled prosperity with the expansion of trade and freedom from 1983 to 2007, it is in large part because falling dependency ratios in the West, Japan, and China combined with steady population growth, technological innovation, and good governance to deliver a large demographic dividend. For those countries today, demographic tailwinds have turned into headwinds. Areas of the developing world, meanwhile, are poised for demographically driven growth, provided they can continue to improve their health, literacy, and governance indicators.

For rich countries, the road ahead is uncharted but potentially promising. On the one hand, developed countries will no longer be able to benefit from a demographic dividend. On the other hand, the United States and other developed countries could offer their enormous reservoirs of capital and know-how to help improve sub-Saharan and South Asian economies by making capital more available and helping build stronger institutions. Although this assistance would greatly improve the lives of Africans and Asians, it would not be just an act of altruism but also a necessary intervention to create the next great engine of global economic growth at a time when the Chinese economy is slowing down. It is unlikely that either India or Africa alone could become the next China, but the combination of the two could create new demand for global products. The alternative, consisting of weaker economies in industrial nations and near-disastrous conditions in the poorest countries, is too grim to contemplate.